Question

10) You are analyzing a B-rated Munipal bond available for sale in the market today. The bond has a term of two years, a coupon of 4.20% paid annually and a face value of $1,000. The market's expected return for B-rated Municipal bonds is currently 5.10% Which of the following equations represents the market value of this bond?

A) PV = 5.10/(1.042) + 1,005.10/(1.042)²

B) PV = 42/(1.051) + 42/(1.051)² + 1,000/(1.051)³

C) PV = 42/(1.051) + 1,042/(1.051)²

D) PV = 51/(1.042) + 1,051/(1.42)²

E) PV = 4.20/(1.051) + 1,04.20/(1.051)²

Answer 1

We can calculate the desired result as follows:

Face Value = $ 1000

Coupon Rate = 4.20%

Time to maturity = 2 years

Rate of return = 5.10%

Coupon Payment received every year = Face Value * Coupon rate

= 1000 * 4.20%

= $ 42

As the bond matures in two years , we will receive coupon payment in first year of $ 42 and at the end of second year we will receive both the face value of bond $ 1,000 and the coupon payment of $ 42.

So, the equation to calculate the present value is:

= [Coupon Payment for 1st year / ( 1 + required return)] + [(Face Value + coupon payment) / (1 + required return) ^ 2

= [ 42 / (1+0.0510)] + [(1000 + 42) / (1 + 0.0510) ^ 2

= 42 / (1.051) + 1042 / (1.051) ^ 2

= $ 983.29

So, the correct answer is option (c) PV = 42/(1.051) + 1,042/(1.051)²

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